Investments & Securities Chapter 1 Homework Issues The Text States That 2013 Had

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Chapter 01 – Investments: Background and Issues

of McGraw-Hill Education.

CHAPTER ONE

INVESTMENTS: BACKGROUND AND ISSUES

INTRODUCTION TO THE INSTRUCTOR’S MANUAL

Welcome to the Instructor’s Manual (IM) for the tenth edition of the Essentials of Investments

text by Bodie, Kane, and Marcus. This market-leading text provides comprehensive information

on investments. Designed to prepare students for a career in the investment industry, it also

serves as an excellent resource for investment knowledge that every individual can use in making

personal-investing decisions.

All data has been updated and sections added that cover new information on topics such as the

causes and effects of the financial crisis of 2008 and the subsequent recovery; the hedge fund

Chapter 01 – Investments: Background and Issues

CHAPTER OVERVIEW

The purpose of this book is to a) help students in their own investing and b) pursue a career in

the investments industry. To help accomplish these goals Part 1 of the text (Chapters 1 through

4) introduces students to the different investment types, the markets in which the securities trade

and to investment companies. In this chapter the student is introduced to the general concept of

LEARNING OBJECTIVES

After studying this chapter, students should have an understanding of the overall investment

process and the key elements involved in the investment process such as asset allocation and

CHAPTER OUTLINE

1. Real versus Financial Assets

PPT 1-2 through PPT 1-4

Investing involves sacrifice. One gives up some current consumption to be able to consume

more in the future (or to be able to consume at all in the future if the goal is simply capital

preservation). Financial assets provide a ready vehicle to transfer consumption through time.

There may be more appropriate investments than real assets for many investors. The distinctions

2. A Financial Assets

PPT 1-5 through 1-6

Fixed-income securities include both long-term and short-term instruments. The essential

element of debt securities and the other classes of financial assets is the fixed or fixed-formula

3. Financial Markets and the Economy

PPT 1-7 through PPT 1-14

Do market prices equal the fair-value estimate of a security’s expected future risky cash flows,

all of the time, some of the time or none of the time?

This question asks whether markets are informationally efficient. The evidence indicates that

markets generally move toward the ideal of efficiency but may not always achieve that ideal due

to market psychology (behavioralism), privileged information access or some trading cost

advantage (more on this later).

A related question may be stated as “Can we rely on markets to allocate capital to the best uses?”

$19.18.

• Yahoo rejected the offer, holding out for $37 a share.

• Billionaire Carl Icahn led a proxy fight to seize control of Yahoo’s board and force the

firm to accept Microsoft’s offer.

• He lost, and Yahoo stock fell from $29 to $21.

• Did Yahoo managers act in the best interests of their shareholders?

The answer to this question really revolves around whether you believe stock prices reflect the

long-term prospects of firm performance or are focused primarily on short-term results. Despite

some long-time periods to the contrary, stock prices do tend to conform to their fundamental

Chapter 01 – Investments: Background and Issues

Corporate Governance and Ethics

Businesses and markets require trust to operate efficiently. Without trust additional laws and

regulations are required and all laws and regulations are costly. Governance and ethics failures

have cost our economy billions if not trillions of dollars and, even worse, are eroding public

4. The Investment Process

PPT 1-15 through 1-16

The two major components of the investment process are described in PPT 1-15, namely asset

5. Markets are Competitive

PPT 1-17 through PPT 1-20

Previewing the concept of risk-return trade-off is important for the development of portfolio

theory and many other concepts developed in the course. The discussion of active and passive

management styles, is in part, related to the concept of market efficiency. The discussion of

6. The Players

PPT 1-21 through PPT 1-27

Chapter 01 – Investments: Background and Issues

Some of the major participants in the financial markets are listed in PPT 1-20. Governments,

households and businesses can be issuers and investors in securities. Investment bankers bring

7. The Financial Crisis of 2008

PPT 1-27 through PPT 1-36

Antecedents of the Crisis

From 2001 to 2004 the Federal Reserve aggressively lowered interest rates. In 2007 the TED

Spread, which measures the spread between LIBOR and Treasury–bill rate, common measure of

credit risk, was around .25%, which is low.

Changes in Housing Finance

Low interest rates and a stable economy created a boom in the housing market, and drove

investors to find higher-yield investments. In the 1970s Fannie Mae and Freddie Mac bundled

mortgage loans into tradable pools by a process called securitization. The securitization model

led to the development of subprime loans (loans above 80% of home value, with no underwriting

Chapter 01 – Investments: Background and Issues

Mortgage Derivatives

Investment banks used risk–shifting tools to carve AAA securities from “junk” loans. The

securities were called CDO’s, or Collateralized Debt Obligations, and they consolidated the

Credit Default Swaps

Credit Default Swaps also contributed to the financial crisis. Credit default swaps are insurance

contracts against the default of borrowers. However, many CDS issuers ramped-up their risk

The Rise of Systemic Risk

Systemic Risk is the risk of breakdown in the financial system, particularly due to spillover

effects from one market into others. By 2007, banks were highly leveraged, with increasingly

The Shoe Drops

On September 7, 2008 Fannie Mae and Freddie Mac were put into conservatorship. By the

second week of September both Lehman Brothers and Merrill Lynch verged on bankruptcy. On

Dodd-Frank Reform Act

The Dodd-Frank Reform Act imposes stricter rules for bank capital, liquidity, and risk